Colin Batchelor looks at some of the implications arising from recent pension tax relief reform
Following the Coalition Government’s radical reforms on the restriction of pension tax relief from 6 April 2011, it is essential that advisers consider the ramifications for their clients. As we are all aware, the key change is that the new annual allowance (AA) for pension input periods (PIPs) ending in the 2011/12 tax year will fall to £50,000 (currently £255,000).
Opportunities do exist for those unaffected by the anti-forestalling rules to make substantial contributions before 6 April 2011; the danger is that it is easy to misunderstand the PIP, which if not used properly, may result in contributions being assessed against the wrong annual allowance with the imposition of punitive tax charges.
A PIP is the period over which the pension input amount for an arrangement is measured for testing against the annual allowance. This is normally an initial 12-month and one-day period with subsequent periods at 12 months determined by the scheme, and is not necessarily aligned to the tax-year. Instead, it could align to the plan anniversary (for example, plan starting on 1 July 2008 – the first PIP ends on 1 July 2009); or for occupational schemes, PIPs could align with the company tax year-end.
The relevant annual allowance limit applies in the tax-year in which the PIP ends, (for example, if a payment is made on 1 December 2010 to an arrangement with a PIP ending on 1 December 2011, the benefits would be measured against the 2011/12 annual allowance). This is crucial as contributions paid (or rights accruing in DB schemes) now could already be measured against £50,000, instead of £255,000, and individuals could fall prey to unexpected tax charges.
As individuals may have more than one pension scheme, the total of all of their PIPs ending in the relevant tax-year are aggregated when assessed against the annual allowance. The PIP can never exceed 12 months (except for the initial 12 months and one day), and no more than one PIP is allowed in each tax-year for each arrangement.
Contributions under any PIP starting on or after 14 October 2010 and ending in the 2011/12 tax year are subject to the new reduced limit.
However, contributions where the PIP ends in the 2011/12 tax year and straddles 14 October 2010 face complex transitional rules. The PIP is divided into two parts – pre 14 October, and post 13 October. Provided the total pension input amount for the period post 13 October is less than £50,000 and the total for the combined periods is less than £255,000, the member will not suffer a tax charge for the PIP ending in the 2011/12 tax year. For rights accruing in DB schemes, a factor of 10:1 applies to accruals up to 13 October 2010, and 16:1 on or after 14 October.
Here’s an example of these ‘straddling’ rules: Carlos earns £500,000 and contributes £20,000 a month (a protected amount under anti-forestalling rules). As his PIP runs from 1 August 2010 to 31 July 2011, he already has one PIP ending in the 2010/11 tax-year.
Up to 14 October 2010 he has contributed 3 x £20,000 = £60,000 (in his current PIP).
From 14 October 2010 to 31 July 2011 he pays 9 x £20,000 = £180,000 (the balance of the current PIP).
If his pension savings remain unaltered, he would fail the first test and incur an annual allowance charge on £130,000 (£180,000 – £50,000). As total pension saving during the PIP is under £255,000 he would pass the second test.
If he reduces his monthly payments to £5,555 (9 x £5,555 = £49,995 (such as, under £50,000)) after 14 October 2010, he would not suffer an annual allowance charge for the PIP ending in the 2011/12 tax-year.
Contributions could then be reduced to £4,166.66 (12 x £4,166.66 = £49,999.92 (such as, under £50,000)) for the next PIP ending 31 July 2012, thereby avoiding an annual allowance charge for the 2012/13 tax-year.
There is currently a closing down sale on the £255,000 annual allowance and PIPs can potentially be manipulated to maximise this (although draft regulations state that it is not possible to retrospectively nominate a change in the PIP end date). Let’s say an individual commenced a pension on 1 June 2009, the first PIP ended on 1 June 2010 (within the 2010/2011 tax year).
The next PIP starts on 2 June 2010 and is due to end 1 June 2011 (in the 2011/12 tax-year). It is not possible to bring forward the PIP to end on 31 March 2011 because then there would be two PIPs, under the arrangement, ending in the 2010/11 tax-year.
However, if an individual started an arrangement on 1 June 2010 and the PIP is due to end on 1 June 2011, it’s possible to advance this to 31 March 2011 because it is the only PIP under the arrangement ending in the 2010/11 tax-year.
Here is an example of a PIP early closure, showing tax planning opportunities and threats: Frank earns £112,950, and has not made a pension contribution this tax-year. He has a final window of opportunity to make the most of the contribution limit of 100% of relevant earnings and pay £112,950 into a new arrangement without being subject to the reduced annual allowance of £50,000. So that this £112,950 lump sum falls within the 2010/2011 allowance, it is crucial that the new arrangement’s PIP closes by 5 April 2011.
As a consequence of this, not only will he receive tax relief on this payment, making a contribution such as this would also reduce his taxable income threshold below £100,000. This would retrieve his personal allowance and give an effective tax saving of 60% on part of this contribution.
Do not forget that the anti-forestalling regime prevails until 5 April 2011 and so options of those earning ‘relevant income’ in excess of £130,000 for this, and the preceding two tax years are curtailed.
Importantly, there is nothing to stop an individual from having different PIPs for different arrangements. So, if it is not feasible to amend the PIP under the existing arrangement because there would be two ending in the current tax-year, the individual could set up a new arrangement and ensure its PIP ended, at the latest, on 5 April 2011. The total pension input amount (the aggregate value of all PIPs under different arrangements ending in the 2010/11 tax-year) would need to be measured to ensure the £255,000 limit is not breached.
Here’s an example: Carol earns £120,000 and her SIPP has a PIP running from 1 August 2009 to 1 August 2010 (falling in the tax-year 2010/11). A contribution of £110,000 was made during this PIP. Carol’s employer would now like to contribute a further £145,000 (subject to the wholly and exclusive test).
However, the PIP ending in 2011/12 has already started and therefore the PIP is deemed a ‘straddling PIP’. As the contribution is being made after 14 October, the amount that can be paid without breaching the AA is £50,000.
What’s the solution?
Carol can establish a new arrangement ensuring that its PIP ends by 5 April 2011. If the end date is not defaulted to the tax-year end, she can ask the scheme administrator to bring this forward. Therefore the PIP will be tested against the annual allowance ending in 2010/11. The total pension input amount will then be the aggregate of the two PIPs for the two arrangements ending in the tax-year 2010/11. This is £110,000 for the SIPP and £145,000 for the new pension plan, totalling £255,000.
Advisers should take urgent action to review whether clients can maximise the £255,000 annual allowance before it disappears, and ensure that those in danger of breaching the lower annual allowance limit will not be caught out.
Unnecessary tax charges can be avoided either by decreasing contributions; and although not possible for all cases, PIP end dates could be shortened to this tax year, or a new arrangement could be established with an end date on or before 5 April 2011.
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